There is no universally accepted definition of the concept ‘household financial stress’, so the
Reserve Bank monitors a broad range of indicators of the health of household finances in Australia. This
Focus Topic provides an assessment of households’ financial health and the incidence of financial
stress across different types of households. The main findings are:

• Early indicators show that financial pressures have increased. Many households are
  facing a squeeze on their budgets and have had to make (in some cases, substantial) adjustments to
  their spending or saving patterns in light of the increase in inflation and interest rates over the
  past 18 months.
• The incidence of severe financial stress has increased but remains low. The vast
  majority of households have had scope to make adjustments to their personal situation, including
  increasing hours worked, reducing their discretionary spending, saving less or reducing their stock
  of savings.
• The group of borrowers at higher risk of falling into arrears on their mortgage remains
  small. Borrowers with low incomes, large loans relative to their income or property
  value, and low savings are particularly at risk.

The Bank monitors a broad range of indicators to assess household financial stress.

Definitions of financial stress vary, which reflects that different households can be in different stages
along the spectrum of stress (Figure 5.3.1):

• Rising budget pressures can be an early indicator of stress. Budget pressures may cause
  households to worry about being able to pay their bills or build savings going forward, and force
  some to cut back on discretionary expenditures or look to increase hours worked.
• Under severe financial stress is the more extreme end of the spectrum. Insolvent
  households are unable to service their debts or pay their essential bills out of their income and
  savings.

Some life events, such as illness or job loss, may push households into severe financial stress
immediately, independent of the state of the economy. In other cases, financial stress can build
gradually from milder to more severe forms as a household exhausts its options to respond to budgetary
pressures. Some households may be able to ‘self-cure’ and exit financial stress – for
instance, through hardship assistance from lenders or by selling assets to reduce their debts –
however, this may involve substantial financial and personal costs (e.g. in the sale of the family home).

Financial stress first and foremost impacts people’s wellbeing but there can also be
spillovers to the broader economy and financial system. Households in early stages of
financial stress might sharply reduce their non-essential spending, which can contribute to or exacerbate
an economic downturn. In extreme cases, financial stress can have implications for financial stability.
Households in severe financial stress are unable to service their debts, which could lead to losses for
lenders and – if sufficiently large and widespread – could cause them to reduce lending or to
become financially stressed themselves.

The Bank therefore closely monitors a range of indicators for signs of financial stress.
These range from early indicators of building financial pressures (such as households’ perception of
their financial situation) to measures of more severe stress (such as loan arrears and other late debt
payments). In addition to these directly observable indicators, the Bank analyses a range of surveys
– such as the Survey of Income and Housing (SIH) by the ABS and the Melbourne Institute’s
Household, Income and Labour Dynamics in Australia (HILDA) Survey – for a comprehensive assessment
of households’ experiences with financial stress and their financial wellbeing. As these surveys
tend to be available only with a substantial lag, the Bank complements this information with loan level
data from the Securitisation System. We then estimate indebted households’ evolving financial
positions in terms of:

• spare cash flows – households’ income available after meeting housing costs
  and other essential expenditures
• savings buffers – savings that can be drawn on when household income is not
  sufficient to meet housing costs and other essential expenditures.

A growing number of households are in early stages of financial stress, but a very small share are
currently unable to service their debts.

High inflation and higher interest rates have reduced most households’ spare cash flow.
In turn, a small but increasing share of households is likely to have to spend more than their
incomes (see Chapter 2: Resilience of Australian Households and Businesses). Consistent with these
broad-based budget pressures:

• many households are making adjustments to their expenditure, as evidenced by slowing consumption
  growth
• households’ sentiment of their current or future financial health has declined sharply since
  early 2022
• the frequency of Google searches of terms related to household financial stress increased earlier
  this year to its highest level since the start of the COVID-19 pandemic
  in early 2020
• financial counselling services such as the National Debt Helpline have seen increased demand for
  their services from the low levels seen during the pandemic (Graph 5.3.1).

At the other end of the spectrum, indicators of severe financial stress have also begun to increase, but
they have remained at very low levels as measured by mortgage arrears rates (see Graph 2.2 in
Chapter 2: Resilience of Australian Households and Businesses) and personal insolvencies
(Graph 5.3.2).

Budget pressures and incidences of financial stress differ across households. Some
households have been affected more by high inflation and higher interest rates and are therefore facing
budget pressures more acutely.

Renters are generally more likely to experience financial stress but do not pose direct financial
stability risks.

Timely, comprehensive and representative data on renters’ financial situations is hard to come by.
Yet, many renters are likely to have been particularly impacted by the recent period of high inflation
for the following reasons:

• Renters tend to have lower incomes. Private survey data covering the period
  from
  February to July 2023 show that renters have substantially lower incomes than mortgagors
  across all
  age groups (Graph 5.3.3).
  Renters have also been particularly impacted by
  recent large rent increases.
  That said, some renters – particularly those
  on low incomes – are likely to have experienced stronger-than-average income growth
  (see
  Graph 2.3 in
  Chapter 2: Resilience of Australian Households and Businesses).

  
  

  
  
  

• Renters have substantially lower savings than mortgagors irrespective of their
  age
  (Graph 5.3.4).

  
  
  

As a result, renters are much more likely to experience financial stress than other households. In 2021,
renters were around twice as likely to face difficulties paying their bills and were around four to five
times more likely to seek help from community services or family and friends (Graph 5.3.5). Renters
could also experience financial stress more severely if the labour market were to soften, as they tend to
be more likely than mortgagors to lose work in economic downturns.

Even though renters are more likely to experience financial stress, they do not pose direct financial
stability risks as they do not have material debts. That said, if a large number of renters were to
default on their rental payments, this could adversely impact the cash flow of investors, particularly
those who financed their investment property with debt. And, if renters were to sharply reduce their
spending, this could contribute to a more material economic downturn.

Mortgagors are facing much higher interest costs, but the vast majority appear well placed to continue to
service their debts.

Mortgagors tend to have higher incomes than renters and have historically been less likely to experience
financial stress. More recently, however, borrowers – except those still on low fixed rates –
have faced substantial increases in their mortgage costs, with the majority having seen their payments
increase between 30 and 50 per cent since April 2022 (Graph 5.3.6, all loans).

Mortgage payments represent an increasing share of borrowers’ income. The share of
variable-rate owner-occupier borrowers devoting at least one-third of their (reported) income to their
mortgage payments has increased sharply, from around 4 per cent in April 2022 to around
20 per cent in July 2023 (Graph 5.3.7). This share is the highest among low-income
mortgagors (defined as the bottom quartile of mortgagor incomes – that is, borrowers with up to
around $78,000 in household disposable income) at around 43 per cent. By
contrast, the share is around 8 per cent for borrowers in the highest mortgagor income
quartile. Further, higher income borrowers can generally absorb the higher debt-servicing costs without
becoming financially stressed because they tend to have significant income relative to essential spending
needs (see Graph 2.8 in Chapter 2: Resilience of Australian Households and Businesses).

Borrowers with larger loans relative to their income (‘higher LTI’) or relative to the
value of their property (‘high LVR’) are more likely to face financial stress. Since
interest rates increased in May 2022, higher LTI loans and high-LVR loans tend to have seen larger
increases to their scheduled minimum payments compared with other variable-rate owner-occupier loans
(Graph 5.3.6). As a result, these borrowers are much more likely to
struggle to meet their essential spending needs. About 25–50 per cent of higher LTI borrowers and about 15–32 per cent of high-LVR borrowers are estimated to have an
income level not sufficient to meet their housing costs and necessary expenses, compared with 5–13 per cent for all variable-rate owner-occupier borrowers,
depending on assumptions about essential expenses (Graph 5.3.8).

Higher LTI variable-rate owner-occupier borrowers whose essential expenses and housing costs exceed their
income tend to have only slightly lower savings buffers than all borrowers in a similar financial
position (irrespective of the Household Expenditure Measure (HEM) used to capture essential expenses). By
contrast, high-LVR borrowers tend to have substantially lower savings buffers and are hence most at risk
of entering mortgage stress (Graph 5.3.9). Consistent with this, higher LTI and in particular
high-LVR borrowers have higher arrears rates than other borrowers (see Graph 5.2.3 in
5.2 Focus Topic: An Update on Fixed-rate Borrowers).

By contrast, other groups of borrowers do not appear to be materially more at risk and
have broadly similar or lower arrears rates to other borrowers (see Graphs 5.2.2 and 5.2.3 in
5.2 Focus Topic: An Update on Fixed-rate Borrowers). These include:

• Those who borrowed at low fixed or variable rates during the COVID-19 pandemic and are now on higher variable rates
  (accounting for 25 per cent of outstanding variable-rate owner-occupier loans by volume).
  The estimated share of borrowers in this group whose income does not meet their cost of living ranges
  between 8 and 18 per cent (depending on the measure of essential expenses used)
  – which is not significantly different to all other borrowers in a similar financial position.
  This is despite these borrowers having had less time to repay the principal on their loan and
  therefore often having larger loan sizes, and the fact that their borrowing capacity at loan
  origination was assessed at an interest rate below their current rate. Moreover, these borrowers have
  broadly similar savings buffers to other borrowers.
• First home buyers. These borrowers tend to take out loans with high LVRs as saving for a
  deposit can be difficult; by contrast, previous home buyers tend to have accumulated equity in their
  properties. Despite some recent first home buyers having
  higher LVRs (and hence lower equity in case of needing to sell if in stress), between about
  6 and 14 per cent are estimated to have living costs that exceed their income, which
  is similar to all variable-rate owner-occupiers. This group also has similar savings buffers to other
  comparable borrowers.
• Investors. While investors have seen similarly large increases in their interest
  payments compared with owner-occupier borrowers on the same interest-rate type, most are likely well
  placed to service their debts. This is because investors tend to have higher incomes and savings than
  other households and have seen their rental income increase strongly over the past year or so (albeit
  generally not sufficient to offset the increase in mortgage costs). Moreover, investors are more
  likely than owner-occupiers to sell their properties to avoid financial stress.

Financial stress does not vary much across Australia. This is despite borrowers in some
regions having seen larger increases in their loan payments (relative to their incomes) – for
example, New South Wales and Victoria have the highest shares of borrowers devoting at least one-third of
their incomes to their mortgage expenses. Housing prices (and thereby loan sizes) largely drive these
differences. While the share of borrowers estimated to have their cost of living exceed their income is
higher in these states, it is not significantly so, with the shares ranging between 6 and
16 per cent depending on HEM assumptions (Graph 5.3.10). In turn – and supported by
the tight labour market across most of Australia – loan arrears remain relatively low, at less than
1 per cent across all states and territories (Graph 5.3.11).